Pension plans account for a large fraction of global institutional investment holdings. In 2008, $24.0 trillion of global institutional holdings was held by pension plans, making up 39% of the total. $15.3 trillion of these holdings were held in U.S. sponsored plans. In comparison with mutual and insurance funds, U.S. pension holdings comprise over 97% of the assets in these classes combined. Given the importance of pension funds as an investor class, it is surprising how little attention has been paid to unique features of pension funds in the academic literature.
We focus our analysis on privately sponsored U.S. defined benefit (DB) pension plans, a group with $1.9 trillion in assets as of the end of 2003 (see Buessing and Soto (2006)). Our analysis surrounds the determinants of decision-making in private DB pension plans. In doing so, we examine a number of related questions.
First, we examine the effect of regulations on the investment choice of pension plans. We focus our analysis on the effect of regulations on asset allocation decisions and managerial assumptions. Exploiting within-firm funding status variation and precise knowledge of sharp institutional discontinuities in the function determining plan sponsors’ mandatory contributions, we obtain causal estimates of the effect of regulatory funding rules on asset allocation decisions. Our approach is similar to the standard regression discontinuity design described by Hahn, Todd, and van der Klaauw (2001), Imbens and Lemieux (2007), and Lee and Lemieux (2009), and applied by Angrist and Lavy (1999), van der Klaauw (2002), Rauh (2006), Chava and Roberts (2008), Lee (2008), and Roberts and Sufi (2009). We find that regulatory funding rules affect asset allocation decisions in a statistically and economically significant way. Fund managers appear to increase the riskiness of portfolios when approaching an underfunded status of 20% of liabilities from below, a result we interpret as an attempt to increase the ex ante probability of ending the plan year above the 20% threshold. We find similar results around the mandatory funding threshold where plans go from overfunded to underfunded status. As in the latter case a milder form of contributions are mandated, the effect we find is smaller.
We also apply the regression discontinuity approach to investigate whether regulations have an observable effect on manager-controlled pension accounting assumptions. Specifically, we examine the effects of the mandatory contribution rules described above, as well as accounting rules dictating amortization charges, on the assumed rate of return on plan assets, an assumption with a direct effect on firms’ income. We find that when plan sponsors are subject to mandatory amortization charges that hurt income, there is an economically and statistically significant positive effect on the assumed rate of return on pension assets when considering within-industry variation. Considering only within-firm variation, we find that this effect is most pronounced when firms experience further decreases in funding status in the year following events leading to income-hurting amortization charges. We find similar results when we consider the effect of mandatory contribution function discontinuities. Namely, we find an effect on the assumed rate of return that is consistent with income-smoothing manipulation only when we consider plans around the institutionally critical 20% underfunded threshold.
Finally, we examine whether pension fund managers are tactical in their asset allocation decisions and time the market. We find that investment managers do not seem to react to changes in the investment opportunity set, as measured by the level of the price-dividend ratio. Recent contributions examining mutual fund managers’ market timing ability include those of Jiang, Yao, and Yu (2007) and Drish and Sagi (2008), with both papers coming to opposite conclusions. For hedge funds, Fung, Xu, and Yau (2002) find no evidence of market timing ability, a conclusion shared by Graham and Harvey (1996) in the context of investment newsletter recommendations. To our knowledge, just two studies address the question of market timing ability in pension plans. First, Coggin, Fabozzi, and Rahman (1993) study the market timing ability of pension fund managers using return-based measures on a small sample of U.S. pension funds, with the conclusion that the average timing measure is negative. One major drawback of their approach is that nonlinear relations between fund and market returns may be due to reasons other than market timing, such as the dynamic trading effect proposed by Jagannathan and Korajczyk (1986). By using holdings-based tests, we avoid this potential pitfall. Second, Blake, Lehmann, and Timmermann (1999) study asset allocation dynamics using a sample of monthly portfolio holdings for 306 U.K. pension plans. However, as pointed out by the authors themselves, many of the conclusions of their analysis do not apply to U.S. pensions, where the regulatory environment and competitiveness of the fund management industry are very different than in the U.K.
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Asset Allocation and Managerial Assumptions in Corporate Pension Plans
